States put trust in mortgage market

COLUMBIA, S.C. — The subprime mortgage crisis has yielded at least one benefit for states: Mortgage-related investments have become so cheap that they are luring some pension funds to buy.

JIM DAVENPORT

COLUMBIA, S.C. — The subprime mortgage crisis has yielded at least one benefit for states: Mortgage-related investments have become so cheap that they are luring some pension funds to buy.

Retirement systems in South Carolina and Pennsylvania are nibbling at the securities, betting that they have been beaten down so much that the ones with good credit ratings could yield strong returns later.

South Carolina is looking to buy $100 million of mortgage-related investments for its $30 billion state pension fund. Pennsylvania, which made money off those securities' troubles in its hedge funds last year, is also betting that they can offer long-term returns.

But the buying this time is very tentative, and may not presage a broader turnaround in these securities.

For South Carolina, the caution means buying into a managed fund. In Pennsylvania, the outside managers the fund hires are looking for bargains. But in both cases, the states emphasize they're only investing small amounts of their overall portfolios.

The bargains are the product of a crisis in the mortgage industry brought on by some lenders taking greater risks by lending to some people who had poor credit histories. The bet was that home values would continue to rise and that these borrowers would be able to refinance before their monthly payments moved higher.

That didn't happen. Home prices fell, the rates on adjustable-rate mortgages ratcheted higher, people began defaulting on their loans and securities tied to mortgages plummeted in value.

Now, some see bargains as investors realize the underlying assets the securities represent are far from worthless.

"Some of the securities that have dropped in value were really very solid securities," said Robert Gentzel, a spokesman for the Pennsylvania State Employees' Retirement System.

"This really has no bearing to the fair market value of these assets anymore," agreed Bob Borden, who oversees South Carolina's pension investment decisions. South Carolina has only put $8 million into that fund that includes some subprime mortgages, but Borden expects the rest to go in rapidly as the market swings from extreme fear toward greed.

"It has gotten to be where this market is oversold," Borden said.

While the banks and other companies that created and sold an array of mortgage-related securities need cash now, pension funds have cash — and long-term investment views.

"They can take advantage of the fact that other parts of the market need that short-term liquidity," said Allan Emkin, managing director of Pension Consulting Alliance in Portland, Ore.

Banks, for instance, also need to comply with federal regulations that require them to have assets backing a percentage of loans on their books. "These banks are strapped for cash and they are forced sellers in the market," Borden said.

Joe LaVorgna, chief U.S. fixed income economist for Deutsche Bank Securities Inc., said for some types of mortgage investments, default rates would have to hit 90 percent at current prices for an investor to lose money.

The beating mortgage-related investments have taken is "a sign that we are dragging along or at what at least is getting close to the bottom of reality," Borden said. "That's the real question. Are we at the bottom of the market? We seem to be getting pretty awfully deep and approaching the bottom."

Nonetheless, "the bottom is hard to call," he said.

Everyone is trying to find the bottom, LaVorgna said. "I think it's possible the bottom could be a little more elusive than current prices suggest."

With banks still cleaning up their balance sheets, "there's just not a lot of risk-taking at the moment," he said.

So don't expect other state-run pension plans to immediately rush back in to mortgage-related investments, said Keith Brainard, research director for the National Association of State Retirement Administrators. "It's going to be a lot more subtle in most cases."

Clark McKinley, a spokesman for the California Public Employees' Retirement System said the nation's largest public pension fund has about $2.4 billion in structured investments related to mortgages — less than 1 percent of its $250 billion fund. But McKinley won't say whether portfolio managers are now angling for bargains on underpriced mortgage investments. Brainard said mortgage investments are typically only slivers of any state's portfolio.

"Florida last fall came to realize it had a lot more this stuff than anybody realized," Brainard said. But Brainard puts that in context: The state really had less than 1 percent of its more than $137 billion portfolio at stake.